- 05 Jun 2019
- Rohit Jaggi
- Finance - BizAv
What are the Basics of Business Aircraft Financing?
What are the essentials of aircraft financing prospective borrowers need to understand? What are the common choices faced, and how can buyers make the right decisions for their needs? Dave Higdon discusses the basics...
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Dave Higdon
Dave Higdon was a highly respected, NBAA Gold Wing award-winning aviation journalist who covered all...
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What are the essentials of aircraft financing prospective borrowers need to understand? What are the common choices faced, and how can buyers make the right decisions for their needs? Dave Higdon discusses some of the basics...
Though the world of aircraft finance bears a striking resemblance to real estate transactions – down to terms and conditions, closings, and title insurance – significant differences do exist. The wise aircraft buyer seeks an expert in the field to assist them in securing the required financing.
Nevertheless, a basic understanding of the process can help buyers have a firmer grasp of the purchasing process. Following are some of the essentials to help you understand aircraft financing, and how it impacts an aircraft transaction.
The Currency of an Aircraft Transaction
First, US dollars are the currency of record for aircraft transactions. That means it’s important to keep track of the exchange rates – especially when you’re dealing with an overseas seller who is quoting an asking price in their local currency.
In such cases it’s best to lock down the price in an agreed currency so you can know what the costs will be in dollars, using the dollar figure throughout the transaction. The lender will certainly be doing the same.
How to Gauge the Total Cost of Financing
Many prospective buyers don’t explore the options for aircraft financing fully enough. While the interest rates matter greatly (and are covered more fully below), so do the terms of the loan and any conditions the buyer must meet. For example:
- What is the length or term of the loan?
- What are the required down-payments?
- Are there any pre-payment penalties?
- What’s the total cost of making the loan?
That total cost will include any fees or costs beyond interest and principal, such as a loan origination fee, closing costs, title insurance and similar. Without knowing all the costs it’s impossible to gauge the total cost of the transaction.
What’s in an Interest Rate?
Usually expressed as an annual percentage rate (APR), interest rates deserve your attention. Buyers should scrutinize lower-than-normal interest rates which may mask other expenses that drive the total cost up. After those hidden expenses are factored, the aircraft financing may actually be less favorable compared to another option with a higher stated APR.
Today, interest rates remain very competitive for business jets and turboprops aged under ten years.
For older business jets and turboprops, the rates may be higher, or other terms may be more onerous (i.e. higher down-payments or shorter terms).
As of this writing several aircraft finance firms quoted rates on late-model business turbine aircraft as low as 3.99% for up to ten years (Part 91 operators), and slightly higher for Part 135 operators. Floating rates tied to the three-month London Interbank Offered Rate (LIBOR) are available from many lenders.
Is Borrowing Really Your Best Option?
Tax laws usually inform whether cash or financing is the best option for an individual aircraft buyer. For several years now Congress has helped buoy business aircraft sales by authorizing bonus depreciation.
More recently that bonus depreciation has allowed qualified buyers to write off 100% of an aircraft purchase on the first tax year available (an option that doesn't necessarily work for all businesses or individuals).
But there's no question that this option influences choices over how to pay for a new or used aircraft purchase.
The debate comes down to a cash versus credit discussion, and the decision hinges on which will benefit the buyer's taxes more.
With today's low interest rates, borrowing preserves capital for other business uses and still allows the buyer to depreciate, write-off the entire cost of the aircraft, or spread the depreciation for several years in order to get the most out of the tax savings.
The right answer to this question will depend on the buyer. However, arriving at the correct one should always involve input from a tax advisor.
Could Leasing be an Option?
A useful alternative to borrowing, leasing comes with some potential pitfalls. Lease transactions work well for companies and individuals able to fully realize the advantages of lease-law tax benefits. Moreover, once the lease ends the lessee need only return the aircraft in the pre-agreed condition.
Of course, the lessor may give the lessee operating the aircraft a choice to extend the lease or exercise an option to buy the aircraft at its current market value, whereby the lessee need only pay the residual value to become the full owner.
Finding the Tipping Point Between Competing Needs
By now you should have an inkling of the value available from the right finance package. The above should serve to highlight how financing is a valuable tool that creates options for the right type of buyer.
Nevertheless, buyers must balance their aircraft needs with forecasted cash flow. Ultimately, as the economy strengthens and the financing institutions become more eager to lend money, they will create new models that capture the attention of qualifying buyers who might otherwise have opted for a cash buy.
The Purchase/Finance Road Map To conclude, the following illustrates the process aircraft buyers can expect to undergo in order to obtain financing for an aircraft purchase:
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